Weekend Edition: The Fed’s Only Escape Is to Trash the Dollar

Harry Houdini was the greatest escape artist of the 20th century. He escaped from specially made handcuffs and underwater trunks, and once escaped from being buried alive. Now, Janet Yellen will try to become the greatest escape artist of the 21st century.

Yellen is handcuffed by weak growth, persistent deflationary trends, political gridlock, and eight years of market manipulation from which there appears to be no escape. Yet, there is one way for Yellen and the Fed to break free of their economic handcuffs, at least in the short run. Yellen’s only escape is to trash the dollar. Investors who see this coming stand to make spectacular gains.

Yellen and the Fed face as many constraints as Harry Houdini did in trying to escape a potential collapse of confidence in the U.S. dollar and a possible sovereign debt crisis for the United States. Let’s look at some of the constraints on Yellen – and the possible “tricks” she might use to escape.

The first and most important constraint on Fed policy is that the U.S. economy is dead in the water. Quarterly GDP figures have been volatile over the past three years, with annualized real growth as high as 5% in the third quarter of 2014 and as low as minus 1.2% in the first quarter of 2014. We have not seen persistent growth or a definite trend – until now. Finally, there is a trend, and it’s not a good one.

Annualized real growth for the past four quarters has been 2.0%, 0.9%, 0.8%, and 1.2%, for an average growth of 1.23%. That’s a trend that will drive the U.S. into a sovereign debt crisis. Deficits are still running over 3% per year and are set to skyrocket as baby boomers retire and claim Social Security and Medicare benefits. In effect, the U.S. economy has flatlined at a level that cannot sustain our deficit spending. Take a look at the chart below…

The second constraint on the Fed is a persistent deflationary tendency. The U.S. economy is not yet in outright deflation. But there are powerful deflationary forces arising from demographics, debt, deleveraging, and technology. That’s important because the Fed’s government debt problems could be solved with some inflation. (Inflation is not a good deal for you, but the Fed doesn’t care about you. They care about the banks.)

Inflation would help to solve the U.S. debt problem because it would lower the real cost of the debt. Making the debt burden sustainable is not about real growth; it’s about nominal growth. Nominal growth is what you get when you add inflation to real growth. For example, if real growth is 2% and inflation is 2%, then nominal growth is 4%. Since debt is repaid with nominal, not real, dollars, then 4% nominal growth is enough to make debt sustainable even if deficits are 3% per year.

The problem is that inflation is not 2% (what the Fed wants). Right now, inflation is closer to 1.5%. With 1.5% inflation and 1.23% real growth, nominal growth is still only 2.73%. That’s not enough to sustain deficits of over 3%.

The third constraint on the Fed is political gridlock. The Fed might be able to cause some inflation if they could employ “helicopter money.” The use of helicopter money requires cooperation among the White House, Congress, and the Fed.

Basically, the White House and Congress would agree on massive spending programs and larger deficits. The Treasury would finance the deficits by issuing more bonds. Then the Fed would buy the bonds with printed money and promise never to sell the bonds. The debt would stay buried on the Fed’s balance sheet possibly forever if “perpetual” bonds were used.

Unfortunately for the Fed, there’s almost no possibility of helicopter money this year. The U.S. has to get past the presidential election. They need to see which parties control the House and Senate and then try to achieve some consensus on a new spending program. That won’t happen until February 2017 at the earliest. That’s too late to get the U.S. out of its flatline growth trend this year.

The fourth constraint on the Fed is their desperate race against time. The Fed needs to raise interest rates so they can cut them when recession hits. The problem is that the U.S. economy may be in recession before the Fed can normalize interest rates. If the Fed cannot cut rates enough to get the economy out of recession, it could become a permanent depression, as what happened in Japan.

My own view is that the U.S. has been in a depression since 2007 (defined as persistent below-trend growth). Japan has been in a depression for over 25 years; the U.S. has been in a depression for nine years. The entire world seems headed in the same direction.

Here’s the math. Economists estimate that the Fed has to cut interest rates about 350 basis points (3.5%) to offset the effects of a recession and stimulate a return to growth. Today, the Fed funds rate is 0.25%. The Fed would have to raise rates 3.25% before the next recession in order to cut them 3.5% to fight that recession.

The problem is that the average U.S. economic expansion since 1980 lasted 79 months. The current expansion has already lasted 85 months. In other words, the next recession is already overdue.

If the Fed rushes to raise rates now, they will cause the recession they are trying to avoid. The Fed’s actual policy has been to do nothing and hope for the best, but that strategy is running out of time.

Those are the Fed’s handcuffs – weak growth, persistent deflation, no helicopter money, and no ability to cut rates to avoid a recession. How can the Fed escape these constraints? How can the Fed get the inflation it needs to both sustain the debt and facilitate rate hikes?

There are four ways to get inflation when rate cuts are off the table. These four ways are helicopter money, world money, higher gold prices, and currency wars.

As mentioned, we may see helicopter money in 2017 if there’s political will in Congress and the White House. But helicopter money does not guarantee inflation. People and companies on the receiving end of government deficit spending may just save the money or pay down debt instead of spending more themselves. This behavior negates the “multiplier effect.” But that doesn’t mean it won’t be used anyway. The Fed never lets reality get in the way of trying out a bad idea.

The second way to get inflation is for the IMF to issue world money in the form of special drawing rights, SDRs. This may happen in the next global financial crisis, but it won’t happen in the short run. The IMF moves even more slowly than the Fed. SDRs may be issued in sufficient size to cause inflation in 2018. But it’s unlikely to happen before then.

The third way to get inflation is for governments to dictate a higher price for gold, perhaps $3,000 per ounce or higher. The idea is not to reward gold investors. The idea is to devalue the dollar relative to gold so the dollar price of everything else goes up. The U.S. government did this with some success in 1933 when it raised the price of gold by 70% in the middle of the Great Depression.

However, this method is so extreme from a central banker’s perspective that I don’t expect it in the most desperate circumstances. We may see this in 2019, but it’s unlikely to happen sooner. That doesn’t mean gold won’t go up on its own – it will. It’s just that investors should not expect the government to force the price higher by official action anytime soon.

If we can potentially expect helicopter money in 2017, SDRs in 2018, and a high official gold price in 2019, what can we expect here and now? How can the Fed cause inflation in 2016?

There’s only one way to escape the room right now – currency wars. The Fed can trash the dollar and import inflation in the form of higher import prices. You can bet a cheap dollar will be on the agenda Sept. 4, 2016, when the G-20 leaders meet in Hangzhou, China.

A cheaper dollar is a complicated play because it involves other currencies. If the dollar goes down, something else has to go up. It won’t be the Chinese yuan or pound sterling. China and the U.K. have serious growth problems of their own and need a cheap currency too.

If the dollar goes down, then the three forms of money that have to go up are the yen, the euro, and gold.

Regards,

Jim Rickards
Editor, Strategic Intelligence

Editor’s Note: As an ex-advisor to the CIA, Jim Rickards is privy to all sorts of information the average American never hears about. Recently, he’s learned of a single event – just 48 days away – that will trash the U.S. dollar just like the Fed wants. But it gets even worse than that…

It could completely gut the U.S. stock market… wipe out U.S. jobs… and vaporize your retirement savings.

Does anyone recall that the productivity of labor is proportional to the capital available? The low wage, low employment problem is directly CAUSED by ZIRP, which punishes savings and thus deprives the middle class of capital to start a new business (the source of most additions to employment), to buy a first home (always a driver of economic expansion), buy a new tractor (raising productivity), providing for their own retirements (new consumption spread forward), and educating their children (an educated workforce is eluding us).

There is no possibility that our problems are insufficient inflation. Our problem is insufficient saving….capital accumulation. It is destroying the productivity of the middle class.

The Fed’s cheap interest rates are making the financial sector wealthy with the carry trade and asset speculation with cheap loans, while crushing the middle class with real inflation and suppressed interest rates on savings.

I read the following paragraph from the above August 13the article by Mr Rickards “The second way to get inflation is for the IMF to issue world money in the form of special drawing rights, SDRs. This may happen in the next global financial crisis, but it won’t happen in the short run. The IMF moves even more slowly than the Fed. SDRs may be issued in sufficient size to cause inflation in 2018. But it’s unlikely to happen before then.” Then shown at the end of the article I checked out Jim Richards’ sneak peak of the big Annoucement, in which he states that on September 30th the IMF will issue World Money. What gives?

Inflation is here big time!!! Just go to the grocery store!!!But, like most(all) polititians, they”re crooks or shysters!!! Why do you trust their manipulated figures???? Why I want the “donald” to get elected is not because I trust him, it’s because I don’t not trust him!!! Happy camping.

I am amazed on how so many accredited people still live in the ‘Theory of Plato’s cave”, Mr. Rickards is dead on correct on what is to come. now for when exactly it will is another story dictated by many complications nevertheless judging from the old world proverb that even outranks Murphy’s law, ” What brings in an Hour, a whole year can not” , still stands. Who ever wants receives but has to weight on which side of the matrix of the cave you want to perceive with. I Thank you for the food of thought.

What do you suggest we do? I am retired, and my husband will possibly retire next year. We have a two small savings account in a local banks, and my husband has a 401k through his job. My husband tells me his 401k is in a “safety” account, which is not affected by what is happening in the stock market.

How is the price of gold set. Trough a trading house? Well that trading house has to be operating and if there ever is a situation where even a small portion of those contracts are settled for delivery there won’t be a trading house. Add in the fact that real gold is a miserable currency. Everyone is dreaming that the price of gold must rise to a useful trading price but it still won’t make it any easier to trade. Look down into your hand a tell me that that lump of metal is really worth $5K My guess is that real trade will survive and countries will use their own currencies to trade. Money traders already exist all around the world as do trade insurance operators. It will be the only good solution to the mad derivative market and fractional lending.

In Canada Trudeau finds his government has no money to spend. So he borrows billions ( with no indication of how it is to be repaid). He then gives some of this borrowed money to the mothers of children to help them pay their way. My question…..is this helicopter money ?

I’m sick and tired of being FED a bunch of BS from crooks, con men and women, gangsters, thieves, shake-down artists, (politicians and the media) being told its good, you need this, we have to, it’s in your best interest only to find out much, much latter, if at all, that you were bent over, your pockets were emptied, they had there way with you and slowly walked away laughing.
It is theft, and if done by a public servant it is treason. Treason was punishable by death at one time. Maybe we should revive that ritual. I guarantee you it would only take one or two. You wouldn’t have many left but I also guarantee those that are left will be doing the job they were elected to do.

Regardless of any action, the status of a country is under reset. I fear that the USA will be no longer the world’s leader in trader, nor the dollar to hold any value. It strains the mind, but we are a world economy, and with social media the have nots see what the haves aquire, and most of the world wants their piece of an allusory pie. We are looking at a financial avalanche, remember the needs of life,, and hang on

Concerning comments on doubt that gold could represent $3k or $5k per ounce, I would suggest to those who pooh-pooh the possibility, that in 1900 you’d not have found anyone who believed or dreamed that gold could come to represent over $1k per ounce. For those who cling to the paper money in desperation , I say: From good old W. Shakespeare, “What is past, is prologue!”. 🙂